Speech given to the German-Icelandic Chamber of Commerce on the Icelandic Economy: economic policy - recent reforms - situation and prospects.
Speech given by the Icelandic Minister of Finance, Mr. Geir H. Haarde
to the German-Icelandic Chamber of Commerce,
May 1998
(translated from German, original available here)
The Icelandic Economy
Economic policy, recent reforms, situation and prospects
Let me first thank the German-Icelandic Chamber of Commerce for this opportunity to address this meeting. I will address four main issues. First, I would like to offer a few reflections on the economic relations between Iceland and Germany. Secondly, I will briefly outline the main features of the Icelandic Government's economic policy and recent reforms with a few comments on the overall economic situation and prospects in Iceland. In this context, I will specifically mention what has been happening in two important areas, namely privatisation and pension reforms. Thirdly, I will move on to discuss the importance of foreign investment and free trade for a country like Iceland. And finally, I would like to conclude by offering a few thoughts on the future challenges for Iceland.
1 German-Icelandic relations
Importance of German-Icelandic relations. As you know, there is a longstanding cultural affinity between Iceland and Germany and many Icelandic writers have been highly respected here, most notably pater Jón Sveinsson, Nonni. Germany has also for a long time been one of Iceland's main trading partners. Last year, the German market accounted for close to one-seventh of our exports, second only to the UK market, and on the import side the German market is the largest single market. By tradition, the fisheries have been the most obvious link between our two nations. For centuries, German fishermen came to Iceland to fish and nowadays fish products account for more than 40 per cent of our exports to Germany. Another interesting feature of German-Icelandic relations is that Icelandic companies have now invested in fishing companies in Germany. I believe that the EEA-agreement between the European Union and EFTA opens up a window of opportunity as regards future relations between Iceland and Germany since this allows for free movement of goods and services, capital and labour.
2 Economic policy and outlook
Let me now turn to my second point, on economic policy, structural reforms and the economic situation in Iceland.Favourable economic environment. The Icelandic economy is at present characterized by strong economic growth, low inflation, falling unemployment, favourable external terms of trade and a balanced budget. The economic outlook is also favourable with an upsurge in foreign investment, notably within the energy sector, and continuing recovery of the fish stocks in the coming years.
Economic policy. Highly instrumental in improving the macro-economic balance in Iceland in recent years has been the overriding economic policy of the Government to maintain and strengthen the stability in the Icelandic economy to ensure continued economic growth and increased employment. Another important policy consideration has been to move the Icelandic economy towards openness, deregulation and liberalization of markets, especially the financial markets. Significant structural reforms have also been implemented in the public sector with corporatization of public enterprises and privatization.
Improved investment climate. The changes that have taken place in Iceland in recent years have strengthened the Icelandic economy and made the business sector more competitive than ever before. This surfaces in a much improved business climate and profitability, a rapidly growing export sector and higher level of investment. As a result, Icelandic enterprises have rapidly increased their investment activity abroad. Also, these changes have paved the way for increased foreign investment in Iceland, especially in the power-intensive industry.
Strong non-inflationary growth. The Icelandic economy grew at an annual rate of 5-52 per cent in 1996-1997, which was one of the highest measured in the OECD area. In the medium term, economic growth is expected to ease slowly down to a sustainable growth level of 3-32 per cent per annum. The growth in recent years is largely attributable to strong domestic demand, i.a. as a result of large-scale energy investments, and rising exports. Although the current account has moved into deficit, this is largely attributable to the strong investment activity in the private sector. In spite of the rapid economic growth, inflation has remained at a level close to the OECD average, in the 2-22 per cent range. The strong growth performance has led to a significant increase in employment and new jobs. As a result, unemployment has fallen from an historical high of more than 5 per cent in 1995 to below 4 per cent in 1997 with a further reduction to about 3S per cent expected in 1998.
Fiscal balance restored. One of the main economic policy concerns of the Government has been to restore fiscal balance after a prolonged period of fiscal deficits. Through extensive consolidation measures, largely by expenditure restraint, the fiscal situation has rapidly improved, reaching a balance in 1997 and expecting to remain in balance in the medium term. The level of public sector debt continues to fall and is expected to fall below 50 per cent of GDP at the end of 1998 from a high of nearly 60 per cent in 1995. As a result, the public sector borrowing requirement has fallen sharply.
Satisfactory economic performance. I think it is fair to say that the economic performance in Iceland in recent years has been satisfactory. This reflects on the one hand a decisive economic policy shift towards greater liberalisation and deregulation where the overriding emphasis of the Government has been to strengthen the macroeconomic stability in the economy and on the other hand a sharp improvement in the underlying economic situation. A clear sign of the improved position of the Icelandic economy in recent years is that Iceland has for some years met all of the four economic criteria necessary for participating in the Economic and Monetary Union.
Progress will continue. Iceland has in recent years been moving from being a country with significant economic involvement by the state and favouritism towards certain industries towards a more open market economy. We have privatized various state enterprises, opened up for foreign investments, abolished exchange controls and increased competition at various levels of the economy. As a result, we are moving fast up the international competitive and freedom tables. The changes in our attitude towards foreign investment have been accompanied by fundamental reform of the government sector and of our monetary and fiscal policies.
Strong privatisation program. The privatisation program has been very active in Iceland in recent years. The main purpose and rationale behind this program is to promote competition in previously sheltered sectors of the economy and reduce the size of the state enterprise sector in order to improve efficiency as well as the fiscal balance. I share the belief of those who argue that the state should not be involved in those activities that are better and more efficiently performed by the private sector. I think that our experience with privatisation in Iceland clearly proves this point. So far, we have mainly been privatising state enterprises and factories of various kinds. We have also incorporated and split up the telecommunication and postal services. The next important phase of privatisation, namely in the financial market, has already started.
Further advances. In the beginning of 1998, the Icelandic Investment Bank Ltd. was formed by merging four investment funds, all belonging to the Government. The sale of about a half of the government shares will start later this year. The two state-owned commerical banks have also been corporatised and new shares will be sold during the year. In addition to this, the Government has been selling shares in several enterprises in recent years, a process which will continue.
Pension reforms in Iceland. Let me say a few words on pension reforms. In many ways, the situation in Iceland seems to be better than in most other countries. Already, in the beginning of the 1970s we established the private pension system and it is now more or less fully funded. Two years ago, similar changes were made to the public pension system and as a result of these reforms, this system will, in due course, be fully funded. Finally, at the beginning of this year important changes were implemented in order to enhance long-term saving in the pension funds and move it further towards a fully funded system. Increased competition between pension funds is also an important element.
A three-pillar approach. In Iceland, we recognise the value of a three-pillar approach, i.e. of a public pension contribution, which should serve mainly as a safety net for those individuals that are at the lowest end of the income scale. The second pillar should be a compulsory fully funded pension scheme and, thirdly, this should be supplemented by a voluntary private pension scheme. It is my firm belief that these reforms have paved the way for dealing effectively with the challenges ahead as regards the growing share of older people in the population.
3 Investment, competitiveness and free trade
Let me now turn to the importance of free trade and foreign investment, ingoing and outgoing, for a country like Iceland.Importance of free trade. Throughout history, free international trade has been of vital importance to the Icelandic economy as we need to import a lot of neccessities. This is even more important today, in the context of increased globalisation and integration in the world. Therefore, the Icelandic Government has and will continue to address liberalisation at all levels within the economy as well as in relation to other nations. We do this because of a genuine belief that our openness to new ideas, new products and new technologies represents the best way to the future. We have been members of EFTA since 1970 and joined the European Economic Area when established in 1994. The membership of EEA has meant that a whole new competitive environment has been introduced, not only in the goods sector but also in previously sheltered service sectors such as banking and insurance.
Enhanced investor confidence. The Icelandic Government recognises the need for foreign capital and therefore emphasises the importance of creating a business climate that enhances investor confidence. Foreign investment has helped us develop an internationally competitive energy sector and is also just recently supporting our global moves in information technology and technical know-how in fish production.
Favourable business climate. We indeed have something to offer. Iceland offers low corporate taxes while the taxes on labour are among the lowest in Europe. The quality of the labour force is high. The energy prices are favourable while interest rates, although still higher than in most of Europe, have fallen sharply in recent years. Overall, the economic and political conditions are stable. Thus, I feel confident that we will see significant increases in foreign investment activity in all sectors in Iceland in the future.
Importance of foreign investment. Foreign corporations bring with them knowledge, skill and technology that generate wider benefits to the Icelandic economy. They enhance the competitive environment, leading to greater choice and a more efficient domestic economy. Foreign investment also plays a key role in complementing and strengthening trade linkages and provides Icelandic companies with improved access to important overseas markets.
Improved competitiveness. The improved economic climate and structural reform have paid off in terms of measures of competitiveness. In a recent survey of competitiveness published in the World Competitiveness Yearbook, Iceland ranked nineteenth of the 46 countries surveyed, up from 26th place when Iceland was first included in 1995. Human capital is considered our greatest asset according to the survey, where we rank fifth, while for infrastructure and domestic economy we rank 10th. Still, Germany ranks higher overall than Iceland or number 14.
Recent advances of Icelandic firms. It is often said that the main benefit of direct foreign investment is not so much the money it brings but the access to new technology, new management skills and new marketing infrastructures. A growing number of high-tech companies in Iceland, specialising for instance in fish manufacturing technology, has also been seeking further linkages in Europe as well as in Central- and South-America and Asia. The latest examples come from Chile, Mexico, Denmark and France where Icelandic companies have either bought domestic facilities or linked up with other companies in the same field.
4 The challenges ahead
The issue of globalisation. One important part of a further internationalisation is a stronger link between enterprises across national boundaries. That is why I am very pleased to be with you today on this very special occasion when the business community in these two countries aims for a further strengthening of these ties. In this context, it is worth noting that these contacts have developed even though Germany is a member of the European Union and Iceland is not. Although Iceland has decided not to apply for membership at present we follow with great interest what is happening in the union, not least with respect to the Economic and Monetary Union. Let me also assure you that we fully recognise that not being members of EMU does not mean that there is room for complacency in our economic policy. On the contrary, there is even a stronger need for following a sound economic policy since we will not reap the full benefits of EMU membership.Value of human capital and innovation. Increasingly, it is not a nation's resource base, climate or proximity to markets that determines future prosperity but rather the productivity and resourcefulness of the people. Such resources are best enhanced by increased relations between businesses across borders. Given the situation in Iceland, it may be inevitable that we will from time to time be affected by forces outside our immediate control. Therefore, we must exhibit adaptability and resilience in order to ride the sometimes bumpy road into the next century.
Strong and dynamic economy. Through a strong, dynamic and a growing economy we will be in a position to control our own destiny. For a small economy like Iceland, a willingness to try new ways of doing things is particularly important. For countries, as for individual companies, it is our human capital that represents the greatest resource and, encouraged and used effectively, generates our greatest returns. This is true today more than ever before. A further opening up of the Icelandic economy is a challenge for the Icelandic Government as well as Icelandic enterprises.
Icelandic/German relations. Let me conclude by saying that I think there are exciting opportunities for Icelandic business in Germany. It is a very important market and I hope that Iceland will continue to be an attractive venue for German investment and trade partnerships.
Footnote.
[Other relations. But German-Icelandic relations are not only confined to our trade relations. For a number of years, Icelandic football and handball players have been playing for German clubs and some have even been training German clubs. Today, many of our best international handball players are playing in Germany and one of our best-ever football players, Ásgeir Sigurvinsson, played both for Bayern München but most notably for Stuttgart for many years where he as captain led them to win the German Bundesliga and was voted best player of the year. I think this variety in our relations bears witness to the closeness in our culture which is very valuable.]
[I also hope that we will be able to help German handball and football clubs win their respective championship titles.]